When it comes to investing, many skeptical investors believe that all good things must come to an end. For those who foresee an eventual crash for popular dividend stocks, though, it looks like the day of reckoning may take quite a while to arrive -- at least if the fundamentals behind many of those stocks have anything to do with their future performance.
Whenever you try to look at the subject of the latest investing craze, it can be difficult to separate out emotion from rational thought. That's why it's important not just to look at stock price movements of dividend stocks but also the key drivers that determine what their dividend payments may look like both in the near term and for years to come.
Another strong quarter for dividends
To get a sense of the overall dividend environment, I like to use the latest data about aggregate dividend behavior. S&P Dow Jones Indices provides a report every quarter that provides a nice summary of the health of dividends in the U.S. stock market.
The second quarter of 2012 continued a long trend of improvement among dividend-paying stocks. During the quarter, companies announced 505 dividend increases, compared to 441 during last year's second quarter and raising the six-month total for the year so far to its highest level since 2007. Meanwhile, with just 37 announced dividend cuts, the breadth of the overall market with respect to dividends continues to look extremely good.
All those dividend increases resulted in an additional $12 billion of dividend payments going to shareholders in the second quarter, which S&P Dow Jones Indices believes is enough to set a new record for total quarterly dividends paid by U.S. stocks.
Why there's room to run
The figures above may imply to some readers that dividends must be nearing a cyclical peak. But historical comparisons show that the long streak of below-average payout ratios continues for dividend stocks. The report said that even though yields rose from 2.58% to 2.77% during the quarter, payout rates remain near their lows, with an average of 31% compared to the longer-term historical figure above 50%. The conclusion the report draws is that further gains in dividend payments should continue for the rest of the year.
Moreover, you can find many stocks that not only have high yields and low payout ratios but also reasonable valuations based on earnings as well. According to S&P Capital IQ, resources stocks Freeport-McMoRan Copper & Gold (NYSE: FCX), Chevron (NYSE: CVX), and Cliffs Natural Resources (NYSE: CLF) have earnings multiples in the single digits and yields well above the 3% mark, but neither pays out more than a quarter of its earnings. Nor are the opportunities restricted to that sector; hard-drive maker Seagate Technology (Nasdaq: STX) and niche insurance provider Aflac (NYSE: AFL) meet the same criteria.
A taxing proposal
However, dividends do have some uncertainty. The current preferential tax rate on qualified dividend distributions will end at the beginning of 2013 unless new tax laws extend it. With the report citing savings of $358 billion during the 10-year span of the dividend tax cut, a reversal of the rate reduction would likely make companies substitute more buybacks for dividend payments, cutting payout ratios still further.
Nevertheless, given the number of investors who hold dividend stocks in retirement accounts, and therefore don't worry about taxes in any event, a collapse in dividend stocks due to tax changes isn't imminent. Moreover, there's always the possibility that new tax provisions will be in place in time to forestall the huge rate increase.
Keep taking the money
As with all your stocks, you have to look closely at the dividend stocks in your portfolio to make sure that their valuations are consistent with your view of their intrinsic value. But with many reasonably priced dividend stocks still available, the death of dividend investing doesn't look likely anytime soon.
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